In the simplest terms, bookkeeping is the process of recording the financial transactions of a business in a way that is illegible, manageable, and translatable to all customers. The term ‘Customers’ refers to whoever is required to, or for whom the books are maintained. Though bookkeeping may have started as a raw and simple means to record financial transactions, it has surely evolved into a complex discipline in itself.
A number of rules, laws, and limitations are involved in bookkeeping in modern accounting processes. Each available accounting method is internationally recognized, standardized, and read in a certain way. Businesses may choose whichever method they deem fit, however, within that method businesses need to adhere to all the rules and standards of the chosen method.
A bookkeeper must know what items go in the ledger, what reflects on the balance sheet, what is to be put on the income statement, and so on. The three stages of bookkeeping are:
- Identification (sorting entries, items, transactions, and their place on books)
- Measurement (comparing results of one business period with a similar period in past)
- Communication (displaying entries, items, and transactions in easily readable standardized formats)
Modern accountants provide analysis, projections, and alternate strategies to the decision-makers of the organizations. It may not be an exaggeration to say that bookkeeping is probably the most serious and responsible of all tasks performed in any organization. There are several occasions where minor mistakes in bookkeeping have led to a monumental crisis in corporate history.
Hence, regardless of the size and nature of the business, every business needs to keep its books updated, well-maintained, and accessible to all concerned. Periodic inspections, compliance with laws, and adherence to bookkeeping best practices are all augmented necessitates of the bookkeeping process.
Accountants in Latvia must:
- Balance the books
- Prepare financial reports
- Prepare profit & loss statements
- Implement good accounting practices
- Pay up in terms of taxes and other dues
- Do scientific representations
- Manage the finances
Bird’s eye view of the accounting process
All financial transactions carried out by and for a business are recorded in a ledger. A ledger is a crude form of record where the inward and outward flow of goods, services, assets, and other items are recorded. Ledgers are then refined into other formats such as an income statement; reflecting the flow of cash in and out of the business, and reporting expenses, payables, receivables, gains, and losses. The bottom-line figure of an income statement that the owners and superiors are mostly concerned with is the profit or loss situation.
Another articulation of a ledger is a balance sheet. A balance sheet balances out the cash inflows and outflows; reflecting the current status of the company’s assets and liabilities. Balance sheets, income statements, etc. are standard accounting practices.
To ensure that business decisions are fully informed, viable, and feasible, accountants need to provide more. Current analysis of books to understand where it stands in terms of assets, liabilities, expenses as well as future commitments and expenses, forecasting crisis and growth projections, are essential to proactively minimize risks and increase profits.
To summarize the process, an accountant performs the below-mentioned tasks:
- Recording transactions (bookkeeping)
- Make payments
- Issue invoices to clients/customers/other organizations
- Articulate ledger data into sophisticated formats (balance sheet, income statement, financial statement, etc.)
- Analysis, projections, forecast (current state, future growth, risks)
Accounting for small businesses
Although the rules and resulting tabulations of accounting processes remain the same, accounting for small businesses is different from that of big corporations. The biggest difference is that the accounting needs of small business owners are entirely different from the board of directors of a large firm. For instance, a small business may only require bookkeeping to satisfy authorities, whereas large firms’ future decisions depend on accounting numbers.
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Important things to record
As stated earlier, the accounting needs of small businesses have a limited scope, and it is important that the accountants know what these requirements are. Businesses involved in sales of shoes, for instance, might be interested in the units sold in each quarter, the cost of manufacturing, the cost of selling, and the net profit. In this example, accountants must have separate account heads for each stage.
The most basic things that small business accounting revolves around are:
- Assets: Company’s resources that have a depreciating value; property, cash, machinery, etc.
- Liabilities: Things that a company owes to others; debts, securities, govt. dues, etc.
- Income: Cash inflow of a company before any deductions; gross income
- Expenses: Cash outflow: utilities, payroll, rent, operation cost, etc.
- Equity: The value of assets minus the liabilities; share of owner/s, undistributed shares, stocks, etc.
Platform to record entries and maintain accounts
Usually, the turnover rate of employees at a small business is higher, hence the organizational memory may not be as deep too. Therefore, it is important that the accounting plans and procedures of the business are recorded clearly for new accountants to follow.
Several accounting softwares are available to businesses that can be bought, rented, or time-shared, both online and offline. The data is secured on remote servers and can be accessed from anywhere in the world with correct authorization and permissions. Unlike large organizations that run tailored software, small businesses can benefit from the ones available in the market.
Probably the cheapest method of maintaining accounts is using the E-tables by Google; where users don’t need to pay money. Though E-tables fulfill the basic requirements, it does have their limitations and the ever-present risk of hacking, and malfunctioning.
Some small businesses outsource their accounting section; it’s cheaper, more professional, but less private.
Method of accounting
There are two basic methods in which transactions are recorded on a ledger; the Single-entry method and the double-entry method. Under the single-entry method, a transaction is recorded once; as a cash inflow, without recording the cause of the inflow. For instance, a sale may be recorded without recording what was sold. This method is simple, crude, and mostly preferred for businesses that don’t have an inventory of their own. Affiliate sales are a good example of such a business.
The double-entry method is a more sophisticated way of recording transactions. The inward and outward flow of cash, assets, capital, etc. are recorded as action and cause of the transaction. A sale of shoes may be recorded as Cash/Bank debited, and the shoes sold credited from the stock. This system allows the development of the books into more meaningful tabulation easier.
The double entry method is more complicated than the single entry, it requires attention from the accountant to place each item in its right place. As each item pertains to a separate head of account, wrong entries may disturb the entire ledger, which may lead to unbalanced sheets, flawed income, and financial statements, and many other defects.
Continue the example of the sale of shoes, the correct entry, in this case, will be:
(Sales of one unit of shoe @EUR1.00 against credit card payment)
In the above transaction, two account heads have been updated, the bank is upped by a dollar, and inventory is lessened by a unit. Now consider an errored record to know how it can complicate things further.
(Sales of one unit of shoe @EUR1.00 against credit card payment)
Here the account head debited is cash instead of a bank. Imagine if there are a thousand sales each day, with amounts varying from EUR100 to EUR1000 including credit cards, cheques, cash, and electronic payments what mess this one mistake can create. People may be searching their bank accounts for days before they realize where the mistake originally occurred. Such errors happen in every business on regular basis and it is always best to avoid such incidents to save money, time, and energy.
Balancing the books
Ledger’s entries though readable do not represent the true picture of the financial status of a business. The data in the ledger is raw and hence needs to be transformed into decision-making information. One such representation is called the ‘balance sheet’. The balance sheet is a snapshot of the company’s assets vs equity and debts.
The mathematical representation of a balance sheet can be:
Assets=Equity + debts
The asset is a wide term that includes property, machinery, account receivables, cash or equivalent (bonds, traveler’s cheques, etc.), goods in process, inventory, raw material, plant, equipment, patents, vehicles, etc.
Equity consists of 4 items, namely, outstanding shares, paid-in capital, retained earnings, and treasury stocks. Liabilities or debts encompass; accounts payable, interest payable, tax payable, accrued expense, short-term loans, etc.
Consider a company that has an account receivable of EUR2000 and owes EUR5000 to a lender at a certain point during an accounting cycle. In a balance sheet, this will be represented as a deduction of EUR3000 and adjusted as an account balance. The reader will immediately know that the business has an outstanding debt of the amount which has been carried forward to the next accounting cycle.
Financial reports are a summary of the financial standing of a business. They showcase the financial transaction of the business over a given period of the financial year. Note that a financial statement is an external document as it is often the first document needed to carry out a company’s audit.
An audit is an activity conducted by government departments, audit firms, etc., and needless to say that the accuracy of a financial statement is paramount. A financial report consists of the balance sheet, income statement, cash flow statement, and explanatory notes.
Auditors, stakeholders, and potential investors require a company’s financial statement to conduct their activities, and hence accountants pay the utmost attention to creating one. A financial statement must cover the following aspects of a business:
- Assets (sale, purchase, retention, depreciation, gains, etc.)
Profit & loss statement
Often referred to as an income statement, a P&L statement is one of the most important documents within the financial statement. Every company maintains a P&L statement to reflect the company’s income and expenses. The total of all cash inflow is called gross income. Later on, expenses and liabilities are deducted, along with other accrued expenses to reach a figure, not as the net income. Furthermore, tax and dues are deducted to finally extract the profit made or loss incurred by the company.
It is a snapshot document, meaning that the intended readers are usually concerned with the last figure; profit or loss. In the long run, year-on-year profit or loss figures are matched to analyze the growth or decline of the business. Decisions are made to either increase income or reduce costs and expenses, or both.
Good accounting practices
Every business, regardless of its size, capital, and format, must ensure that its books are well-kept and updated periodically. At least once a month all books should be matched; the ledger, balance sheet, income statement, cash flow statement, etc. This way any discrepancy will be contained within the same month instead of rolling on to the next. The more cycles an error completes the more severe will be the consequences.
Secondly, following the legal requirements is critical. Imagine a firm maintains its books impeccably, but they do not meet the regulations of the country, resulting in penalties, and more.
Payments of dues
The accounts department of a firm (whether outsourced or in-house) is responsible to keep the business paid up in terms of taxes and other dues. In many countries where each tax is handled by a separate department, accountants need to be more vigilant regarding the deadlines. Property tax, energy tax, water tax, VAT, etc., may or may not be payable by a business, knowing them and keeping abreast is essential nonetheless.
Some taxes are refundable by the state in the form of a rebate. For instance, VAT, Excise tax, and capital gains tax are refundable in many countries. In Latvia, 10% of the annual income tax is refundable provided the income remains within a certain threshold. Usually, the tax paid is adjusted for future tax payable, however, in some countries, it is returned in form of a cheque drawn in favor of the business entity.
The paid taxes are submitted to the authorities each fiscal year.
Scientific representation of accounting
In this age of globalization, businesses need to act quickly, be prepared to take spontaneous decisions, and cash in any opportunity that comes their way. Especially with the explosion of online business, decision-makers must have a keen eye on the trends. A few years back an online campaign took the world by surprise; it was termed the ‘#MeToo” movement. The objective of the “Me too” campaign was to highlight workplace harassment incidents and create awareness among the public. Far away from the objective, a few wise entrepreneurs cashed the opportunity by producing “#MeToo” t-shirts, coffee mugs, and other such items for sale.
The act that a few opportunists gained from an incident are nothing to right homerun about, what is fascinating is that they were aware of their potential to do so at the right time. One way to keep pace with such global fads is that the financial standing of the firm is readily available when required to know if the company’s finance can meet the tasks. Modern accounting techniques have embraced scientific representations as a key tool to allow decision-makers to make quick decisions in time.
Dynamic charts, real-time sales data, demographical preferences, goods in production figures, changes in variable and fixed costs, and many other important items are available to reach a concrete decision in seconds.
Bookkeeping is an important part of financial management. The term financial management refers to the process whereby an organization utilizes its capital and cash resources. For instance, the cost of goods sold (COGS) compared to the income generated by sales are correlated; if the cost goes up the prices go up too, and so does the income. However, an increase in COGS and income may either keep the profits at the same level or weaken even further.
Consider an item ‘X’ takes EUR2 to produce and it sells for EUR3 at an outlet; sales, in this case, are EUR3 and the profit is EUR1 (with no other factor of deduction). Now the cost goes up by a dollar and the item is sold for EUR4. You see that there is no effect on the profit, however, if we consider an additional expense for marketing the new price, the profit margin weakens as the expense has to be added to the COGS.
This was just one small example; in reality, the executives have to manage a myriad of tasks that relate to financial management. Other examples can be the volume of raw material to procure, or to order when required; the latter is known as Just-in-time (JIT). How much inventory of finished goods is necessary, what seasons affect the sales, controlling the COGS, controlling transportation costs, addressing the goods returned and expired/damaged goods, and so on.
As the company grows so does every aspect of the process, so the challenge is to keep the growth sustainable, as growth does not necessarily mean an increase in profits. In some instances, growth can actually cause a decrease in the end profit. You may be producing more and selling more, but to sell more you will be spending more on marketing, logistics, sales team, and other related items, eventually lowering the overall profits of the company.
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